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A Blockchain-Based Solution to Liquidity Needs

In a world where growth moves faster than payments, many small businesses struggle to pay off their urgent capital expenditures.

Companies of all sizes have short-term costs that are integral to their operations: Office rent, short-term investments and employee salaries are all generally paid on a weekly or monthly basis, while accounts receivables can remain unpaid for 90 to 120 days. The current form of invoice financing — the process by which small- and medium-sized enterprises (SMEs) sell their short-term assets for immediate payment — puts these businesses at a disadvantage. Companies without long credit histories are often ineligible for funding and most businesses can’t afford the commission fees charged by factoring companies.

But now that Bitcoin and several other cryptocurrencies have been battle-tested as acceptable forms of payment, entrepreneurs are betting that they might be the answer for SMEs with outstanding accounts receivables.

Rapid Industry Growth

Invoice factoring is the most popular method of invoice financing; it involves companies selling their invoices to a factoring company at a discount. Factoring companies view unpaid invoices as assets, especially if they belong to creditworthy customers. Assuming it is a matter of when, not if, the invoice is paid, financiers are generally willing to provide liquidity to small businesses in exchange for a portion of that invoice.

Businesses with creditworthy customers and long billing cycles are the most frequent users of invoice factoring. Think of logistics companies that need to pay a large number of drivers, companies with long government contracts, or textile manufacturers that have to purchase all of their raw materials far before any sales are recorded.

Globalization and the growing profitability of SMEs have driven the increasingly strong demand for invoice factoring. Most banks require significant collateral and a long credit history for any type of business financing. While it’s become more economically viable to run a small business, credit restraints have not changed. It is this funding gap that has created a substantial need for short-term financing. Similarly, increased global commerce has accelerated faster than merchants have been able to collect payments from touch points around the world. In short, our current financial infrastructure has not been able to innovate at the pace necessitated by the growing world economy.

Invoice factoring is rapidly growing on an international scale. United Capital estimates the global invoice factoring volume is currently $3 trillion, and is growing at an annual rate of 24.8 percent. Asia and Europe make up the two largest factoring markets in the world, where numerous countries are experiencing over 20 percent annual growth. Most notably, China’s economic dominance has paved the way for a 54 percent annual growth rate over the last five years.

These extremely valuable solutions are not without their defects, however. Invoice factoring is not cheap — creditors can demand up to 10 percent of the receivables as commission. For small businesses that already have trouble paying their immediate bills, these fees can stand in the way of their survival. The verification process is also arduous and relies on extensive labor. Checking borrower credit scores, confirming delivery of goods and services, and assessing accurate invoice terms involve handwritten signatures and require considerable resources which drive up factoring premiums.

A Better Way 

Blockchain technology is well equipped to solve these problems and is being proposed as a solution for small businesses with smaller short-term capital needs. Blockchains are great for tokenizing financial assets and enforcing complex changes in ownership. Given the vast number of intermediaries necessary to manually assess the risk of each invoice, factoring can be made much more efficient and equitable by decentralizing the verification and payment functions.

“With blockchain technology, every invoice is unique and can be assessed by a credit scoring algorithm, providing automatization and transparency to the whole invoice financing process,” noted Jure Soklic, cofounder and CEO of the Hive project.

Just as initial coin offerings (ICOs) have surpassed venture capital — the most prevalent traditional financing model — Soklic intends for Hive to help SMEs move beyond traditional banking for their financing needs. A peer-to-peer marketplace powered by the Ethereum blockchain can connect growing small businesses with a burgeoning crowd of investors. Liquid blockchain assets allow virtually anyone to participate in the invoice factoring process.

Businesses are able to upload their invoices with full confidence that their financial information will remain cryptographically hidden throughout the financing cycle. Hive assesses the creditworthiness of borrowers through its own adaptable algorithm, rather than via outdated manual calculations. Invoice verification issues are alleviated through enterprise resource planning (ERP) integrations which allow users to automatically upload all necessary information for evaluation. Similarly, all financial agreements are recorded within and enforced by smart contracts.

Blockchain technology applications like Hive are pushing the boundaries of peer-to-peer financing structures. Reminiscent of how venture funding was once exclusively reserved for venture capital firms but eventually became available to a range of investors, blockchains and liquidity in crypto markets promise to democratize the invoice factoring industry.

With numerous new applications going to market, at least a handful are bound to fail. We can, however, be certain that industries rife with counterparty risk and financial exchanges are off to a good start.

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